Emerging markets falling behind, but only for a moment

Opinion: Investors should know developed world can’t maintain outperformance

By

MatthewLynn

LONDON (MarketWatch) — Sluggish growth. Structural problems. A drag on global growth. That might sound like a typical description of the big, lumbering economies of the U.S., Europe and Japan. Except it is in fact increasingly a description not of the developed world but of the emerging markets.

The financial data firm Markit reported this week that the divergence between the developed and emerging economies, as measured by its business activity index, has hit the widest level since it started collecting the data back in 2005. Not only has the gap widened, it has also undergone a remarkable reversal. While most of the time the emerging markets have been significantly ahead, now the positions have switched.

The developed world is expanding faster, and at an accelerating rate, than the newer economies of Asia, Africa and Eastern Europe.

China foreign direct investment disappoints

(2:52)

China's Ministry of Commerce reports that foreign direct investment totaled $8.6 billion in May, down 6.7% from a year earlier. Dariusz Kowalczyk from Credit Agricole CIB speaks to the WSJ's Deborah Kan about the outlook for the next half of the year.

While that may reflect the position for the last couple of years, it can’t last. In fact, most of the developed world is simply bouncing back from very depressed levels, while a few of the major emerging economies are going through a very rough patch. The emerging markets will soon be outperforming again — and anyone who buys into those markets while they are as cheap as they are now will do well

For most of the last three decades, investors had a simple set of rules about the global economy and where to invest. The developed world was relatively low growth, but compensated for that by offering a high level of security. The emerging economies offered far higher growth. But they were also far less stable. It was a simple trade-off — growth versus stability.

This year, that has gone into reverse and dramatically so.

JPMorgan Global PMI/Markit

For now, developed economies have more momentum than the emerging markets that are supposed to have all the potential.

It is the developing world that has slowed down, while the old economies have performed much better. Markit’s PMI figures for the developed world, which measure business confidence, rose to their highest levels in May since all the way back in February 2011. That was despite a downturn in Japan, as an increase in sales tax came into effect. The emerging markets by contrast saw a slump in confidence. The gap between the two is now the widest it has been for nine years, and it is the developed world that is on top.

The days when the BRICs, the Next-Eleven, and the MINTS (Mexico, Indonesia, Nigeria and Turkey, in case you are having trouble keeping up with all the acronyms) were set to dominate the global economy seem from a different era.

Growth has slowed dramatically in all of those countries, And stock markets have done poorly as well. Take Germany and Poland, for example, two countries that are very close to each other, and both members of the European Union. Germany DAX index
DAX, +0.46%
has more than doubled in value since 2009. Poland’s Warsaw index
WIG, +1.42%
is up only 50% over the same period, and has stagnated over the past six months.

The same is true of most emerging markets compared with their developed neighbors. Up until March, the MSCI emerging markets index
891800, +0.81%
had underperformed the developed world for three straight years.

The crucial issue is whether that is simply temporary or represents a more durable change. Can the developed world reassert its traditional supremacy?

There are some reasons for thinking the outperformance can last for a while.

Under President Barack Obama, the United States has pulled back from actively policing much of the world. Whether right or wrong — and it is certainly understandable after the blood and treasure spent in Iraq and Afghanistan — the result is going to be a lot more small, nasty wars.

We have already seen that in Ukraine, and now in Iraq. Don’t be surprised if there are plenty more over the next couple of years. That inevitably spills over in the markets. The Russian market
RU:RTS
was down sharply on the Ukraine conflict, and its economy has started to contract. Iraq is not much of a market, but neighboring Turkey, which has a major economy, will be dragged down by the chaos in the region.

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